One year ago, as the Covid-19 crisis had just begun, wrote about its potential inflation implications from both a cyclical and a structural standpoint. Cyclically, the crisis was already generating a combination of demand and supply shocks that could only increase short-term inflation volatility and sectoral fragmentation. Structurally, we saw its potential to accelerate policy and institutional changes that, adding to pre-existing factors, could at some point question the continuation of the 40-yearold ‘Volcker’ disinflationary trend, although the case was very open at that time.
Today — with the crisis still unfolding despite there being some light at the end of the tunnel — we remain in the mid of its short term contradictory inflation shocks. Longer term, the way policies have unfolded during the crisis strengthens our call that — during the rest of the decade — inflation could be higher than during the 2010s.
Tracking inflation trends and the inflation regime that may unfold as a result of the Covid-19 crisis is extremely important from an investor standpoint, as some asset classes may prove to be more resilient and outperform during periods of higher inflation. In a regime of normal inflation — between 2% and 3% — credit tends to perform well, due to improving economic fundamentals, as does equity, particularly quality, value and cyclical markets.
With higher inflation, tighter financial conditions will halve equity performance to single digits and bring fixed income, with the exclusion of inflation-linked securities, into red territory. Diversifying across a broad range of asset class becomes paramount to dealing with a normal inflationary regime, with upside risks.